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Five years back Moody’s and Fitch credit rating agencies (CRAs) reinstated Indonesia to ‘investment grade’ ranking, recognising the country had both recovered from the 1998 crisis and recorded a decade of good growth. But the third of the Big Three - Standard and Poors (S&P) - is still thinking about it. The CRAs guide foreign portfolio decisions and international credit flows but that's not all; their views on what is good policy also put considerable pressure on a country to fall into line.

The CRAs have a parlous track record: they gave AAA ratings to high-risk mortgage-backed securities destined to fail when the US housing bubble burst in 2007. They still had Greece rated ‘investment grade’ in 2010. Perhaps as a result, S&P has tended to be ultra-cautious. This might seem to be a sensible response to earlier mistakes, but the result is that foreign investors miss opportunities to share in the profits of Indonesia’s now well-established growth performance. Worse still, Indonesian policy-makers feel constrained to run unnecessarily restrictive budget policies, to the detriment of growth.

When S&P last reported on Indonesia in the middle of last year, there might have been reason to mark Indonesia down because of the fiscal position. The budget deficit had been creeping up towards the legislated limit of 3% of GDP and the then-finance minister seemed unable to use the opportunity of a tax amnesty to shift tax collection onto a sustainable upward trend. Since then, former finance minister Sri Mulyani Indrawati came back from a very senior World Bank role to resume her old job and has brought her accustomed panache to the task. The tax amnesty was invigorated, and while there are still serious doubts about its longer-term effectiveness, there is at least some prospect that those who came forward to claim forgiveness for past tax evasion (in return for a tiny tax payment) will now become the basis of a larger tax-base in future years. Indonesia, with a population of more than 250 million, has only 10 million who file income tax returns.

If S&P’s fiscal concerns were assuaged by Sri Mulyani’s expenditure-cutting efforts, it has found other matters to justify delaying an upgraded rating: a weaker company sector and hence higher non-performing loans in the banking system.The rating has remained below investment-grade.

S&P's ranking of Indonesia is now clearly out of line with other similar countries that have investment-grade status: for example India, the Philippines and South Africa. If the morale boost from Sri Mulyani’s return is not enough to shift Indonesia into the same category, what more would Indonesia have to do? The budget is now well inside the 3% limit and the government has demonstrated its willingness to cut expenditure to keep it there. The deficit is significantly smaller than India's and South Africa's. The current account deficit is well inside the 3% limit that financial markets see as the safe boundary. Government debt is low. Foreign borrowing is modest. Foreign exchange reserves are well over $US100 billion – an ample (perhaps excessive) level. The banks may have some bad debts, but they are strongly capitalised. If bank bad debts are a ratings-concern for Indonesia, why is Italy investment-grade?

It is easy to see why this would irk Indonesia’s macro-policy makers. Why should Indonesia pay significantly more to issue government bonds than India, when India’s banks are a mess and internal and external deficits would pose far greater risk to creditors? Against a wide range of countries, the Indonesian government cost of borrowing is high.

The higher interest rates on government bonds are not the only penalties caused by not being well-rated. The portfolio managers who orchestrate global flows of private capital (successors to the gnomes of Zurich) make their decisions largely on the basis of CRA rankings and index weightings that reflect these same rankings. They all stick closely to the benchmark allocation. A better ranking not only means cheaper borrowing, but bigger inflow.

Thus the pressure on policy-makers to please the CRAs is strong. But does this make for good policy? The CRAs’ caution might restrain profligate governments, encouraging greater budget discipline. But if policy-makers have already put in place sensible budget and debt limits (as Indonesia has done for many decades) the excessive conservatism of agencies like S&Ps just encourages Indonesia to curtail budget expenditure at the expense of growth.

This makes no sense for Indonesia. Nor does it make any sense for the portfolio managers who have curtailed their investments in Indonesian bonds, guided by these overly conservative assessments. Indonesian bonds provided foreigners with by far the highest overall return among the emerging markets in 2016 – well over 20%. Those portfolio managers who missed out on this high return should now be reminding S&P that it is possible to be too risk-averse.